Saturday, January 24, 2009

Zero Hedge makes fun of sell side research often. After all who doesn't. But sometimes we are pleasantly surprised, such as when we read Goldman's weekly economic analysis piece for the week of January 23. Several issues discussed in the report include an overview of the remaining arsenal of governmental responses to the mega crisis we are in, both in the fiscal and monetary realm, a sober estimation of just how bad the real troubled asset situation in the U.S. may be if we remove the wool from our eyes, as well as what needs to be considered before making an appropriate policy move.

A key issue in the current market environment is the sole reliance on fiscal stimuli to push the economy out of this slump, as monetary policy will be a non factor for a long time due to the zero lower bound on nominal rates. Nothing new there. What is interesting, however, is that John Hatzius of Goldman Sachs, referring to the original Taylor formulation of monetary policy definition, extrapolates that based on data that the Fed is likely seeing, fund rates in 2010 "should" go negative, to the tune of -6% !

(If you don't care about the reasoning behind this conclusion, skip ahead to the next part).

A little math for those curious - Taylor's thesis is that the Fed Open Market Committee (FOMC) sets its funds rate target according to the rule:

i=r*+p+0.5(p-p*)+0.5(y-y*)

where i is the nominal fed funds rate, r* is the equilibrium real funds rate, p is the inflation rate, p* is the Fed's desired inflation rate, y is the (log) level of real GDP, and y* is the (log) level of real potential GDP. Using core PCE index for the inflation reading, and CBO estimates for real GDP (tangentially, Q4 2008 GDP number is out next Friday, consensus at -5.5%; GS says -5.9%, Zero Hedge is at -6%), and assuming 2% for both equilibrium real funds rate and desired inflation rate, equation implies -2% Fed funds rate for Q4 2010. Goldman takes the Taylor formulation one step further and replaces the GDP gap with the unemployment gap, and allows coefficients on the inflation and unemployment terms to be estimated based on empirical data, resulting in the following formula:

i=2.7+p+0.3(p-p*)-1.9(u-u*)

This relationship puts more weight on the GDP/unemployment gap, and implies a much lower funds rate of -6% for late 2010. Intuitively this makes a lot of sense: as debt is currently perceived as an overwhelming liability, the government should compensate people for accepting credit. Plus all the talk about stimulating lending will cease once people receive free money to borrow. Of course this is all a hypothetical argument - monetary policy, at least conventional, can not go below zero fed fund rates. Maybe unconventional policy is required.

So what type of response will be needed if Goldman's assumption is correct? If an "appropriate" funds rate is -6%, then "appropriate" LT Treasuries rates, mortgage rates, high grade (and maybe even high yield) corporate rates also have to be negative. In order to drive yields on these securities to much lower levels (if not necessarily negative yields) the Fed would need to engage in massive purchases of much lower quality assets, including HY bonds, non-agency mortgages, CMBS and even equities! And we are talking Massive, not what is contemplated in terms of current policy measures in either size or scale. Which explains why the fiscal response is critical (more on that later) - monetary stimulus is not only powerless to do anything at this point, but monetary logic implies that a fiscal push is needed now more than ever.

What are the practical implications? Deflation is staring us in the face. This is unavoidable, and will become more and more evident as consumers eliminate inflationary expectations from their behavior (i.e. not selling a house whose mortgage is underwater until "the market turns"; recent housing sales patterns in cities such as Greenwich already indicate this is happening). Additionally, the fiscal response will have to be much more pronounced if it is to be effective: GS is worried that the effective stimulus package in 2009 is only $259 billion, of which just $54 billion is infrastructure spending (more below). Unless the Senate bill expands significantly on the House version, it will be impossible to push the economy back to positive growth by the end of 2009.

So what are the key issues as a much more comprehensive fiscal response is contemplated? They can be summarized most neatly as follows: 1) severe shortage of capital; 2) opaque and illiquid balance sheets; and 3) complete policy uncertainty.

Severe shortage of capital. GS estimates that US institutions will bear loan losses of over $1 trillion (this number could be much larger as will be noted later). As such, the $250 billion of new bank capital provided by TARP last year and the $350 billion raised from private investors falls well short to cover these losses. Even assuming banks are able to exploit tax loss benefits, the system is undercapitalized. It is estimated that at least $200 billion is needed to return the system to a minimal acceptable ratio of tangible equity, and that much more than minimum is needed to spur lending to consumers and corporations. and to insure against possible larger losses if the base forecast is wrong.

Opaque and illiquid balance sheets. Bernanke said it best: "a continuing barrier to private investment in financial institutions is the large quantity of troubled, hard-to-value assets that remain on institutions' balance sheets." As Zero Hedge has harped on previously, the arcane asset marking methodologies used by different financial companies have made investors disbelieve any disclosure about "true" value. The GS Financial team recently estimated that major banks were holding subprime mortgage loans at values ranging from 57 to 90 cents on the dollar. The questions about balance sheet values only raises questions about bank solvency, making investors further unwilling to invest capital. The original TARP was geared at addressing this concern, by purchasing bank assets, however it was subsequently perverted into its current form emphasizing bank recapitalizations without addressing the balance sheet issue.

Policy uncertainty. As further government intervention is inevitable, its form and timing will have important consequences for financial firms, owners, creditors and the entire financial system. The biggest concern here have been the constant policy shifts in 2008 as the crisis spread. Of biggest import is that the government has been unable to make up its mind where in the capital structure of a troubled company it will inject capital, and as such, which balance sheet liabilities are safe for investors to participate in. The table below shows just how dramatic the lack of a clear intervention template has been.

The conclusion is that private capital will not be a major aid to the financial system until the uncertainty around regulatory flip-floping has diminished. As long as private capital is unwilling to be allocated, the government will be forced to shoulder the effort of recapitalizing the system alone.

So what is the correct approach to a fiscal, or otherwise, rescue?

The complexity of the problem, and its resolution, has been constantly highlighted by swoons in the market on any potentially adverse news, by the TARP's initial skeptical reception and its subsequent transformation to a bank recapitalization vehicle, by different models of dealing with the "systemic failure" risks, including the US, the British and the Swiss model, and many other aspects. Fed Chairman Bernanke has suggested three ways of dealing with bad assets: 1) an asset guarantee program along the lines of the UK approach, as was done in the "asset pool" creation at Citi and Bank of America, 2) a direct government purchase of assets, and 3) the creation of an "aggregator"/"bad bank" that would buy assets from financial institutions, which would receive shares in the bank and cash. First, however, key questions that must be answered before the correct policy approach is decided upon are among the following.

1. Just how much in troubled assets is out there. The answer depends on the scope one is willing to attribute to this, of course. The narrowest definition involves just the most troubled assets: subprime residential mortgage loans and securities, which would imply bad assets with a face value of roughly $1 trillion, of which half is held by US banks. If one expands the definition to include option-ARM loans, second liens, CMBS, credit card debt, and consumer auto loans or in other words all assets with a cumulative loss rate in the near double digits, the total face value of such asset would reach almost $10 trillion, of which $5.7 trillion is held by US banks. One can easily see the dilemma here: a narrower definition would limit upfront government payments and be easier to implement but would leave more residual uncertainty after the rescue is "complete."

2. How to value troubled assets. As most securities are marked to market already, despite attempts by many lawmakers to change the accounting rules, the emphasis here is on whole loans which are a major component of the mortgage market. And again a dilemma emerges: the more transparent market pricing mechanism policymakers decide upon, the larger the capital shortfall in the system will be. Valuation options include existing bank marks, "marking to model", a spin on Level 3 asset marks where asset managers and banks work together to estimate losses, the recently popular "hold-to-maturity" value, or most transparently, complete mark-to-market approaches which would result in the lowest valuations.

3. What to do with troubled assets. The choice is whether to keep the assets on the banks' balance sheets or to transfer them to government controlled, special purpose entities. The first choice implies a system of "ringfenced" guarantees, which has a low upfront government cost. We have previously written about this issue here. The more expensive option would leave banks with transparent balance sheets and might enable the government to modify loans more rapidly.

4. Where in the capital structure to inject capital. The government must choose whether to protect the taxpayer or the institution itself. If the common equity base is larger, the more losses can be absorbed without insolvency, however the more diluted and less insulated from losses taxpayers become.

5. How to deal with banks that are insolvent at realistic values for troubled assets. There are four main choices here: 1) recapitalization via government purchases of assets at the banks' marks: this would be most detrimental to taxpayers who have to fund the different between the artificial and real marks on bad assets; 2) direct recapitalization of banks while diluting shareholders, as was done with TARP V2; 3) debt-to-equity swaps (forced or otherwise); 4) forbearance, or allowing banks to earn their way back to adequate capital levels, which has the most risk if insolvency is a real risk. And then there is nationalization and shuttering: two options which few have breached but might become more and more attractive.

6. Who pays for all this. Main costs would be associated with asset purchases and recaps. It is likely that trillions in purchasing power will have to be made available, as that amount will definitely be necessary to address an median assumption of troubled assets around $3 trillion (see above) which is much, much more than has been authorized or is currently on the table. This means that policymakers will need to request much more from congress very soon, ironically contrary to what Tim Geithner has naively said will be the case, or have to decide on a strategy of asset guarantees, due to the lack of an upfront cost.

One things is sure: piecemeal, gradual, indecisive, subjective and nontransparent fiscal policy decisions will only exacerbate the problem, while increasing the final cost to taxpayers and investors, and prolonging the term of the current Great Depression V2.

In surely a harbinger of many more such episodes to come, Ryan Brinkerhoff, 24, apparently lost his mind last night, and tried to set fire to the 34th floor of 7 World Trade Center. The man, who Linkedin states is currently (or rather was) a Director of contract integration at DRW Trading group, and a 2004 graduate of Metropolitan Community College, flipped out at 3 am when security cameras captured him grabbing a container of cleaning fluid and splashing it on the doors and phones of his DRW office; a Port Authority cop managed to arrest the nutso before he could ignite the fluid.

Ryan was later laughing as he was being led away in handcuffs, asking reporters "Why are you guys taking my picture." We are not surprised that Ryan is insane: in his meetup.com profile, the guy lists the following as his interests, "whiskey, beer, dining out, hobbies, volleyball, ex-midwesterners, softball, bowling, ex-chicagoans, bicycling, chicago cubs, chicago bears, shar-pei, dog rescue, pets & animals."Anyone who is a fan of the cubs and bears has some serious pathological deviations.

...To Los Angeles. The latest victims are 91 year-old Zsa Zsa Gabor, together with her ninth, and 30 years old youngerhusband, Frederic von Anhalt. Apparently the duo, competing with Kirk Kerkorian for the weirdest nonagenarian title, invested $10 million with Madoff through a Los Angeles-based money manager that has not yet been identified. And continuing the game of blame the fund-of-funds, the "money manager never told the couple about Madoff or explained the risks." The old couple's lawyer has said he is representing five clients who together have lost $35 million.

Adopted German prince Anhalt said in an interview that he and Gabor may face financial ruin, and the couple be forced to sell artwork, jewelry and their Bel-Air home. The man who claimed he may have fathered Anna Nicole's baby Dannielynn (makes perfect sense, after all another really old, really rich, or formerly rich dude) said "It's a big hole, you know. We didn't expect that. When you count on the returns, you depend on the money. It's bad. You go to get your money back and all you have is a bunch of worthless papers."Also, the man who once was found naked, handcuffed to the steering wheel of his Rolls Royce, after allegedly being robbed by a trio of female bandits who had stolen his wallet, clothes and jewelry at gunpoint, added "My wife is close to a heart attack and I'm close to a nervous breakdown. If I was in New York I would take a baseball stick and hit this terrible man over the head." We could not describe it more eloquently ourselves.

And of course Russian focused funds which are already down enough to make Ashley Dupree blush.

What does one notice when looking at these numbers? Well, for one, that everyone is up. WTF? The market is down 8% YTD and 90%+ of all hedge funds are up??? This implies that the hedge fund bandwagon has been fully reconstituted, this time with one massive short bet. We can't wait for the inevitable VOW-like short squeeze once the first guy in line starts covering. Another thing is that if every hedge fund is making money, who is losing it? It is not retail, cause most retail investors are either fully invested in Mattress Onshore Fund LP or buying Treasuries, so it leaves mutual and pension funds. And while we don't doubt the last two are suffering a lot, there has to be something very shady with such HF performance. But that is what one has to expect when your survival is measured in monthly if not weekly performance updates: someone will always find the loophole to the system.
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Friday, January 23, 2009

While John Thain will be enjoying his creme of the crap status of reviled interior decorators for some time, Dick Fuld is about to upstage him in the shady asset transfer category. Cityfile has broken the following bombshell: the Gorilla's $13 million home on Jupiter Island, which was held by both Mr and Mrs Dick, was recently transferred singly to Kathy. Dick sold his portion of the house on 265 S Beach Rd, Jupiter Island to his wife for the princely sum of $100. The transfer occurred on November 10, as the sordid details of Lehman's bankruptcy were becoming public knowledge.

(265 S Beach Road, Jupiter Island)

Additionally we did some extra work and tracked down the public info in Martin County's Tax Collector database on the Fuld's estate (available here). Last year the couple paid $197,193 in property tax alone; this year the amount due is $205,410. All the unemployed Lehmanites who lost their life savings will be pleased to know their former boss is still doing relatively ok. Also the public Recorded Document search in Marin County will present the Gorilla's signature in all its florid glory on the Transfer of Warranty deed.

Paul Kedrosky points out something that will put a dent in many of the talking heads' arguments about housing picking up again in the beat down states. Seems Wells Fargo's 30 Year conforming mortgage is up something like 90+ bps from the several week ago trough of 4.7%. Can't be good. Especially knowing where 30 years Treasuries trade, and all the agency paper being bought by the Treasury with every dollar printed.
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S&P expects the US corporate default rate to reach all-time high of 13.9% this year, a significant revision of its previous projection a 7.6% base-case and the consequence of “a substantial worsening of the economy and the financial environment. The baseline projection of 13.9% would result in an unprecedented trough-to-peak increase of almost 13%, outstripping the rate of increase observed in any prior default-rate cycle since the start of [S&P's] series in 1981."

Also:

As Credit Sights analyst Chris Taggert puts it, "The market is faced with the prospect of a default cycle tantamount to the worst historical periods outside of the Great Depression Fundamentals hurt, weak balance sheets maim, but liquidity kills."

In an amusing expose on the negative basis trade, Bloomberg has identified AllianceBernstein and TIAA-CREF as the winners in the trade where Deustche Bank and Citadel crashed and burned. In a nutshell, a negative basis is where you buy CDS and a bond at the same time while picking up carry, or a positive coupon, due to a dislocation of the prices. This is normally a "riskless" trade as you are technically protected from bankruptcy of the underlying asset for the period of time until the maturity of the CDS, usually 5 years. Problems arise when everyone and their grandmother is also involved, which is exactly what caused Volkswagen stock to hit a 1000 euros last year. When the stampede of other participants tries to unwind, the original basis which would have been as tight as 20-30 bps can explode all the way to 1000 bps, dooming all people who are still involved to some very brutal margin calls, potentially leading to fund shutdowns. This is exactly what happened with Boaz Weinstein's "SABA" group at Deutsche, and is the main reason why Citadel was down over 50% in 2008.In 2007 every hedge fund would snap up even 5-10 bps of negative carry and lever it up 20-50x... Ah those were the times.

While in "theory" the trade is, as we said, riskless, if in the time between now and the end of the protection contract there is another episode of "deleveraging flaring", investors, who get involved now chasing the carrot of 4-6% in risk free return/year, may very well find themselves on the street once the negative basis goes from 400 to 4000, at least hypothetically. With the all too vivid example of Volkswagen still fresh in everyone's memory, very few brave souls will actually put the basis trade on now, for fear of what may happen tomorrow. So opportunities of risk free 5% will likely persist for quite some time. And if any further damnation is needed, Citigroup "strategist" Mikhail Foux is quoted as saying, “For those situations where there’s a risk of some sort, you should probably be putting on basis trades.” Well done Mikhail.
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Former Drexelite and PE legend Leon Black has struck gold after panhandling in front of the headquarters of Calpers and The Teacher Retirement System of Texas for 16 months. Bloomberg reports that a name is sure to get you far, $15 billion dollars worth of far, even as your existing investments are worth exactly 0 cents on the dollar. With such pristine investments as Realogy, Linens N Things, Harrahs, Claire's, Momentive and many more, we can only surmise that the investment memorandum had a 90 page biographical section focusing on Leon's prior phenomenal record, and the only mention of his last three year LBO track record was hidden deep in the 2 or 3 risk factors on the back cover. "For all the private equity funds, Apollo has returned 28% through March 31" states Bloomberg. We assume that would be March of last year and does not include the performance of the most recent Apollo LP Fund 6 or whatever it is at latest count.

After buying $15 billion of debt last year at what it then claimed were all time low prices, the firm lost even more as the value of this purchase proceeded to lose another 20-30%. “We were probably a little early,” Black told the audience today. “We’ve been traversing our way through that.”

We are curious if anyone has any clue as to where Apollo is currently marking the equity value on their existing fund investments, and how long it will take regulators to go after so-called "Level 3" assets, which are probably evaluated by call centers in Calcutta.

Additionally, Apollo seems to be raising a $500 million hedge fund to trade copper, gold and mining stocks. We assume that is because the fund is convinced there is no way these investment can trade any lower... Dejavu?

At last check, LUV was down 18%, or $1.75 to $8.06. Despite posting earnings that were a little better than expected yesterday, Calyon analyst Ray Neidl cut the stock to a Sell, with a $7 target. As we had previously noted, any airline which will forcefully deplane a hot chick for wearing a miniskirt deserves all the wrath of the market (that, and some other reasons as well).
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Despite losing over 35% of its combined savings in the stock market, the general public had taken Wall Street's shenanigans in stride. However, what could likely be the straw that breaks the camel's back of public patience, may very well be Gasparino's office inventory of John Thain. And while everyone, Obama included, is focused on the platinum plated port-a-potty in the former executive's office, we are pretty sure that many other corporate bigwigs are currently quietly loading up U-Hauls. And if they are not they should be, before one of their very own disgruntled employees could very well decide to snap a candid picture with their iPhone of their corner office kingdom's holdings, and post it for general entertainment. We don't want this to be taken seriously, but it will be a hoot to see Mary Schapiro trying to earn her SEC stripes by going office to office and checking the fair market value of installed office toilets.

And while we appreciate the esthetic value of office paraphernalia, there are several firms (which shall remain nameless, but some of which could be said to be $10+ billion plus hedge funds in the Times Square area, and a couple sweet corner offices in the Stamford general vicinity) which we are quite sure are dismantling everything that is not nailed down right now and are silently carting it out of the back door.
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Qimonda, a unit of chipmakerInfineon, filed for bankruptcy today "after failing to secure sufficient financing following a slide in memory-chip prices this year." The company has 12,200 employees.

In an e-mailed statement, Qimonda stated "The insolvency petition is the result of the massive drop in price in the DRAM industry and dramatically decreased access to financing on (sic) the capital markets."

Where will this ripple to: one could list Powerchip Semiconductor and Winond Electronics, Taiwan's largest and fifth-largest memory-chip makers, respectively.

The lack of financing should come as no surprise - as we commented recently, there is virtually no financing available to distressed companies. With GE Capital, traditionally the biggest Debtor In Possession lender, on the verge of saying "Enough", it is likely to only get much, much worse...
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Xerox (XRX) announced in its Q4 press release that its earnings for 2009 will likely be about $1/share, significantly below the consensus estimate of $1.13. We will keep a close watch on them to see if they merit a Death Watch badge in the coming months.
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We usually make a lot of fun of Yahoo Finance for their sophisticated outlook on the economy. In this case they may have been on to something. While not disclosing anything new, this article cites Howard Davidowitz, and Britt Beemer who note that due to people's recent predilection to actually saving instead of maxing out all their credit cards, the following retailers will likely not make it thru 2009:

Charming Shoppes

Eddie Bauer

Timberland

Ann Taylor

Zales

Sears (ESL likely not to be too happy about this one)

Other companies that will likely be on the verge in 2009 according to Yahoo, include Starbucks, Sprint Nextel, Mrs Fields, Applebee's, and Cheesecake Factory. We would be particularly sad about the last one's demise as we are quite fond of their desert menu. Alternatively, in a silver lining to this Great Depression, one should short dieting companies as America's obesity epidemic may finally get a reprieve.

In a recent press release, insolvent trucking company Greatwide Logistics, announced that it was "sold" to an investor group consisting of DE Shaw and Centerbridge. While no cash changed hands, the two Hedge Funds have agreed to a debt for equity swap: the company's total debt would be reduced by 77% from $620 million to $140 million.

Surprisingly, company advisor Miller Buckfire was unable to get Ron Burkle's Yucaipa to invest in the deal: the Clintons' favorite financial advisor had previously invested in bankrupt Allied Holdings and PTS, although after both of those promptly went back to insolvent status, it seems the supermarket magnate has had enough and is focusing on Barnes and Noble. It is to be seen if Greatwide can avoid the same fate. Centerbridge has already been burned once in the auto space when it invested in Dana Holdings in 2007, another Miller Buckfire special.
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It is always entertaining to listen to Mark "Hogan's Bottom" Haines speculate about implied defaults, recoveries and what not... So we decided to dispel some ambiguity and speculation by presenting a brief overview of what the implied bankruptcy rate is, at least mathematically.

We have chosen as a reference security the HY10 index, one of the most liquid indices indicative of the High Yield space, which consists of 100 different HY companies (for constituents click here). We will write about some more advanced topics such as the fair value spread between the index and the implied spread based on its constituents in another day. If instead of High yield defaults, one is interested in implied defaults for Investment Grade names, then the appropriate index would be the IG11, or the most recent roll, of Markit's index representation of 125 investment grade companies. For most of all synthetic traded indices you can click here.

The implied default spread for a "security" such as the HY10 index can be calculated easily using the CDSW function in Bloomberg. As the implied default cumulative default probability is simply a mathematical function based of the price of the security, or alternatively the spread, and its projected recovery rate, we can easily see what JPM calculates the cumulative default rate for a security or an index would be thru any given point in time. Below we present a CDSW screen based on a 40% assumed recovery (more on this in a second). The output cell is highlighted, and highlights that based purely on math, there is a 67% cumulative chance of default by March 2014. As this is an index, the argument would probably go that 67 of the 100 companies that make up the index would go belly up over the next 5 years.

A peculiar twist arises if one changes the recovery assumption for the cume default formula: the default assumption is 40% for a security such as the HY10 index (one particular class of outliers are municipal CDS, where the recovery rate is set to 80% - the next several months will present ample chances to test this assumption). So if instead of using 40% we drop the recovery rate to 20%, as all this does is fudges with the price equivalent spread, we get a different cumulative default probability as shown below:

As one can see, the default prob drops substantially by 13% at the 5 year border. Of course if one were to crank the recovery rate all they way down, the default prob drops to a manageable 45%.

So this is all the secrecy behind the math. There are many resources on the web that dig much deeper into this and I encourage additional reading. Like I mentioned earlier, if instead of the HY universe one is interested in the IG world, then the appropriate index would be IG11. There are other indices such as XO and Main which focus on crossover credit names, or euro denominated, so you can tailor the exposure to your liking and see what the implied default is.

Again keep in mind this is merely math, and the default rate is cumulative. There is no fundamental analysis involved at all in default probability projections. So for all those who say the price implies Great Depression type default level and how this is extremely insane, keep in mind this is what the market is saying. And unless you are AQR Capital, the market is usually always right... unless it's wrong of course.
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Thursday, January 22, 2009

In one of those nauseating mirror-in-a-mirror type of news events, NYT reports that the NYT is in advanced sale-leaseback talks with W.P. Carey. NYT did not disclose to the NYT how much W.P.Carey would pay, what the cost to repurchase is or what the rent cost would be. “Because we are in continuing discussions, we cannot comment on the status of the sale-leaseback,” Ms. Mathis, a spokesman for NYT said.

A little about the low profile W.P.Carey:

Founded in 1973 by William Polk Carey, W. P. Carey has its headquarters in Rockefeller Center in New York. It operates in 14 countries and arranges sale-leasebacks for a wide variety of industries. The company has about $10 billion in assets under management, about $2 billion of which is owned by its public company. The other $8 billion in assets are owned by W. P. Carey’s four real estate investment trusts and managed by the public company.

Everyone knows there is something very screwy about LIBOR, with opinion ranging from it's way too high to the opposite. We also have been quite vocal in our opinion of the TED Spread but that's irrelevant for the time being. Lately we have been looking at the most recent BBA data for the 3 month LIBOR submission by bank and while the average is 1.122%, the range is quite wide: 1.04% at the tight end to 1.204% at the wide. What confuses us is that the banks that submitted the lowest rates are the ones that have the most governmental independence, notably BofA and JPM, while the other end of the range is represented by pseudo nationalized banks such as RBS, in which the UK government recently acquired a 70% stake, and UBS, which had all of its bad assets swept by the Swiss National Bank in exchange for a loan (read more about the Swiss model here).

The implication is that with more governmental involvement or even virtual nationalization, the cost to lend to another bank creeps higher, when compared to entities such as BofA and JPM which still, at least theoretically, carry all their bad assets on their books. This intuitively is very confusing as the cheapest LIBOR should come from the nationalized entities, that have a full governmental backstop.

So while LIBOR's moves in itself have been very puzzling lately, the components of LIBOR and their relative values provide an additional layer to the puzzle.

A $100 million loan BWIC made the rounds today. Roughly a third of the names in the list are € denominated, with the biggest among them is MacDermid 2.25% TL at 9 million.In the dollar denominated space most names are relatively obscure with the most sizable being Sensus 2% TL-B1 at $8.7 million and Grant Forest 1st Lien at $7 million.Deleveraging over? Not so much.

"2008 was the first year that we lost money since we opened our doors in May 1996. We are disappointed about our 2008 result, and we are sure you are as well."...."We don't know where the bottom will be and don't want to bet the farm on guessing, so we did our buying with restraint."....All this, and a very personal vendetta with the German authorities on how the Volkswagen bandwagon could have been allowed to lose money, you can read here.
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After a long and costly battle between highly leveraged Hispanic TV company Univision, which was LBOed in late 2006 by a consortium of billionaire Haim Saban, Madison Dearborn, Providence, Tommy Lee and TGP, for $13.7, and has a bout $10 billion of mostly covenant lite debt, and Mexican soap opera maker Televisa, the two have finally decided to settle this afternoon.

As a result the company bonds and loans all were up: the 1st lien cov-lite TL was up 5 points to 52, the 7.85% bonds due 2011 were well bid in the low 60s, while the 9.75% Toggle notes due 2015 were up 2 to 21.

Curious if the $3.7 billion of equity "value" is still marked on the books of any of its sponsors. Anyway, as the company has a debt/EBITDA of 14x, the answer probably doesn't matter. March 15th is the next interest payment date on the PIK notes, which will likely be paid in kind (i.e.more debt) so a critical date for bondholders will likely be July 15 when the 7.875% have an coupon due. Most credit fund managers by then will likely be on permanent vacation, which explains the daytrading enthusiasm to bid up the bonds today.

CNBC reports John Thain had bought 84,600 shares yesterday. This translates to a loss of over $70,000 in one day. Enough to buy two commodes on legs or about 14 port-a-potties, which may be more prudent as the New York Unemployment Benefits hotline is still off the hook for the 4th week running.

As we were bored and there is only so much you can stare at MC Cabrera's.... face, we decided to investigate if the rumors of a mass exodus at Bank of Financial Lynch were true. We happened to pass by 133 East 64th and sure enough things seemed like an ordinary Thursday at Bernies.

looks like the media have that one staked out pretty well..

So we continue down to 42nd and Ave of the Bank of Americas...

The facade of the building is as expected, with the bulk of renovation proceeds obviously having been funneled to John Thain's office... Wood panelling instead of glass, and a roof which is still wrapped up in scaffolding

Inside we had expected a ghost town, but contrary to expectations, there seemed to be at least one person on the trading floor:

And the only indication of any raping and pillaging was this undercover cop exchanging donuts with a police guy by the main entrance...

*NEW YORK STATE LABOR DEPARTMENT PRESENTS DATA IN RELEASE*NEW YORK STATE LOST 100,000 JOBS IN LAST 3 MONTHS OF 2008*NEW YORK STATE UNEMPLOYMENT RISES TO 7% IN DECEMBER :NYC US*NEW YORK JOBLESS AT HIGHEST SINCE JUNE 1994, STATE REPORTS
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Good to see that mutual funds, even smallish ones, aren't faring any better than their BSD "hedging" brethren. In the words of Janus Capital CEO Gary Black, "the 4th quarter, for us and for everyone else, was dead." Janus' largest fund, the $7 billion Janus Twenty Fund fell 42% last year while the somewhat smaller Janus Orion Fund dropped 50%. Maybe they can rename it something cooler and people will forget all about this abysmal performance?

Janus announced that it will abandon the institutional money-market business, even though it manages over $7.9 in such accounts. The Company has already fired 10% of its its staff.

We are all licking our chops in advance of Bill Miller's Legg Mason "earnings" call next Wednesday.
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The Donald managed to convince his bondholders and senior lenders that he is worthy of yet another temporary reprieve, and announced a two week forbearance extension early today. At this point February 4 is the D-Day at which point the $53 million unpaid interest on the $1.25 billion 8.5% Notes due 2015 become fully due. Curious what can happen in the next two weeks, but it is definitely not going to involve a sale of the Trump properties in Atlantic City which at of a recent visit could easily qualify for ghost town status. One thing is pretty sure: soon-to-be son in law Jared Kushnerwon't be providing any rescue financing, he has his own hands full.
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Dubai's Istithmar investing company, which purchased the Company for $942 million in 2007, says it is sick of this whole aspirational consumer bullshit and wants a refund... Seeing how all things Dubai are crumbling right now, one can imagine this is more of a firesale than a controlled exit. David Jackson, CEO of the naive Dubai company has said he will not sell Barney's for less than the amount it paid for it (if you are lucky to get half, the bank that does the deal is worth every dollar of its 1.5% M&A fee). Istithmar had suspended its vice chairman (or chairman of vice) and CFO in September after he was detained for alleged embezzlement.
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Gasparino's high placed sources have notified him of a high level meeting at BofA at 11:30 am this morning at which John Thain will most likely be booted out.

What about Ken Lewis?

Good riddance

********UPDATE*********

Gasparino reports that Thain had spent $1.22 million to redecorate his office at Merrill, and paid his driver over $230,000 last year.

Some details on the interior decoration: Biggest beneficiary was Michael S. Smith design which received $837,698 for the project (Also Michelle Obama's designer, and who received $100,000 from the White House for his services). Among items purchased were:

After blowing over a hundred billion dollars propping up its currency, Russia's Central Bank has had enough and beginning tomorrow it has set the weak end of the Ruble's trading range against a basket of dollars and euros at 41. "Bank Rossii has finished with the major gradual correction of the borders of the technical corridor that determines the permissible flucatiations of the value of the dual-currency basket" according to an incomprehensible statement by the Russian Bank... Translation: short the ruble.

The weakest level the ruble will be allowed to fall to against the dollar is 36/$ (at 32.7 currently).

New York Mayor Mike Bloomberg testified before the state assembly ways and means committee about what the proposed NY State budget would mean for NYC. In a nutshell, NYC is on the verge of 1970's Taxi Driver status. Mike is cementing his 3rd term with such soundbites as "Economic conditions have deteriorated beyond what anyone anticipated."

Some entertainment: the squabbling between City and State (Bloomberg v Patterson sounds more appealing) is escalating to fever pitch: "[The New York State] budget includes some smart proposals - but unfortunately, it also contains serious flaws. In too many instances, it uses the fiscal crisis as an excuse to shift State expenses to New York's localities - in many cases, permanently. All localities are being asked to take a bitter pill; New York City is being asked to swallow an entire bottle", and "[a pressing item in the State budget] is the Governor's disappointing proposal to exclude New York City - and only New York City - from State revenue-sharing." (much more in the report)

Bottom line of what the current environment will imply for NY residents: "Higher City taxes and also thousands of fewer cops, firefighters, and teachers - all compounding the local effects of the recession. And in the long run, it would make it that much harder for the City's financial services industry to rebuild itself. Make no mistake about it: Raising taxes on those with the flexibility to move their businesses - as was done in previous crises - will lead to an exodus that will hurt us for decades and have devastating consequences for the entire state."

Next item of focus in our opinion: the New York City pension fund. Last time we checked it was down about 50% year over year. Who will be the gutsy one to break the sad new to all the retired NY workers that their pensions are about to be eliminated due to lack of funding.
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BofA estimates that the U.S. Treasury and Federal Reserve combined, now are responsible for directly supporting about 70% of the banking system liabilities and 20% of shareholders' equity. Presuming there is virtually no equity value in U.S. banking, which would of course be the case without systemic support, then liabilities equal assets. In that case, in a government mediated vicious circle, U.S. taxpayers have indirectly paid off 70% of the loans that the US banking system has underwritten to U.S. taxpayers...

We say one resolution to this whole problem is balance the two sides of the equation: write off the taxpayer loans that the government supports, remove the systemic crutches, inject any new rescue funding at the preferred level, and voila - here is your bank rescue.

The drama in U.K. financials this week highlighted the systemic division as to how different governments approach the "bail out" problem absent of an outright nationalization. The current two main options on the table, which Obama's administration will have to pick and choose from unless he decides to nationalize Citi, BofA, and others outright, are the "aggregator bank" and the "bad bank" models, as seen in the U.K. and in Switzerland, respectively.

Swiss National Bank (SNB) Model

In the SNB model, a Special Purpose Vehicle was set up to acquire up to $60 billion in bad assets from UBS' balance sheet. SNB provides 90% while UBS keeps a 10% equity piece (first loss) in the form of an option to acquire the remaining assets after the loan has been paid off. The main difference between the Swiss arrangement and what the U.S. has done with Citi and Bank of America, is that the bad assets are removed from UBS' balance sheet while they remain on the books of the two US banks, though ring-fenced and with a low 20% risk weight.

In Switzerland, the National Bank takes the UBS bad assets off the balance sheet of UBS, placing them into the government sponsored SPV. A key advantage of this approach is that it clearly separates the legacy bank into good and bad portions isolating the uncertainty into the SPV. A key difficulty remains pricing of the assets. The SNB states a reliance on an "independent valuation agent" which is indicative of the current environment's "objective" valuation options.

The ultimate losses for Swiss taxpayers will not be known for years, with a degree of protection set in the 10% size of the first loss component.

UK Model

In the UK, the approach is almost inverse: instead of bad asset isolation, the UK government has been focused on injecting large amounts of equity into troubled banks, even nationalizing some. In this week's example of RBS, the government is raising its equity stake from 58% to 70% by converting GBP 5 billion preference shares into common stock. Despite the UK treasury's recent plans for an asset purchase facility and an asset protection scheme, so far equity infusions have been the only viable model used.

Wednesday, January 21, 2009

GDP at 6.8% was not a surprise: it was Right on top of expectations. This is compared to 9.0% for the same period last year.PPI came out at -1.1%, a whole 100 bps lower than consensus, and much lower from the 2% last year.CPI was 1.2% versus an expectation of 1.6%. The decline in CPI indicates deflation is picking up; the more notable decline in the PPI is more troubling as it is a leading indicator for much lower CPI numbers down the line.Deflation is usually a leading indicator to many more bad things.
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After yesterday's bungled swearing in ceremony, Obama was sworn in repeatedly in the privacy of the White House today at 7:35 pm due to a misplaced adverb. At yesterday’s inauguration ceremony Roberts misstated the oath as “execute the office of president of the United States faithfully” and Obama followed suit.

The Constitution requires presidents to take the following oath: “I do solemnly swear (or affirm) that I will faithfully execute the office of president of the United States, and will to the best of my ability preserve, protect and defend the Constitution of the United States.”

Obama's spokesman Robert Gibbs said the decision to reswear Obama was taking out "an abundance of caution, because there was one word out of sequence."

The market anticipated this apparently, and decided to have a proper Obama rally, unlike the failed one yesterday.

In what will likely be tomorrow's #1 scandal on CNBC, FT reports that Merrill had decided to pay bonuses in December ahead of their usual payout time in February, and just three days before the merger with Bank of America closed. What is more troubling is that the shell of a company had allocated a total comp pool for distribution that was $15 billion or just 6% lower than 2007. BofA apparently had no problem with this accelerated payout. However, within days of the go ahead decision "BofA officials said they became aware that Merrill's fourth quarter losses would be greater than expected and began talks with the treasury on securing additional TARP money."

And sure enough days later Joe Lewis bought $1.2 million of BAC stock, frontrunning the US taxpayers who funded bailout number 2: this time the TARP check was for $20 billion, or roughly enough to cover the comp paid out weeks earlier at Merrill.

Good to know that all the Merrill employees were so critical that the flight risk was worth $15 billion, or enough to almost bring the successor company down. Any headhunters know what Angelo Mozzillo is saying his comp for 2008 was as he is looking for a job? It is surprising to us that with all these news of gargantuan corporate impropriety at BAC, nobody has started rioting or looting the glassy eco-friendly skyscraper at One Bryant Park.

The downsized plans for Valery Kogan's anex at 18 Simmons Lane, which were presented at last night's Greenwich, CT council meeting, were put on hold again (the last time Kogan tried to create the biggest septic nightmare in Greenwich, he was voted down 3-2). The original pro forma house at 54,000 sq. feet and 26 toilets would have been the largest single-family home built in Greenwich since new housing plans started being reviewed in 2001. The new proposal which called for only 38,000 sq. feet and 15 toilets was not voted upon by the commission.

Charles Lee, Kogan's neighbor from across the street, said the commission "objects to this proposal on three grounds: scale, traffic and use. It is a large government-like building (Ed. well, yeah, the guy is a Russian), and isn't consistent with Simmons Lane". Two neighborhood associations, the Northwest Greenwich Association and Round Hill Association also opposed the house, saying the structure is part of a trend of "megamansions" that threaten the quality of life in the city.

As for proposed additions in the anex, here is a summary of some of the items that were in the architectural plans:

indoor pool in the basement

1,200 sq. foot gymnasium

12 person theater

billiard room

game room

massage room

wine cellar

fiber optic lights that arch into the swimming pool

guitar shaped patio

winter garden with 4 statues

septic system for 480 people (what is it with the plumbing fascination?)

When asked "why would anyone in a private residence who wasn't planning on massive entertainment want 15 toilets", Kogan's lawyer responded "There is a bathroom for each bedroom and then there are powder rooms to every part of the house."

As investment banking is now dead and sell side research is even more useless than it ever was, people are stumped over how and where to get their investing ideas. There is only so much drivel you can hear on CNBC and FoxNews before losing your mind, and you are close to firing that "analyst" you hired a few months ago to come up with the new lead-to-gold idea, but who has already lost you and your fund a ton of money by pounding the table that AAPL will come back dammit. So what is a fund manager/retail investor/trust fund baby with an E*trade platform to do? Here we list some suggestions.

Anyone who has ever used a retail brokerage platform and traded a stock or two on their own has likely found himself at Yahoo! Message Boards. The place that angry shorts (in recent months not so angry), angry longs, and everyone in between can use as a venting conduit, but is too busy or lazy to set up a blog, has inevitably posted under a fake alias touting some "secret" about a stock that would suit one's agenda. The problem with Yahoo and other message boards is that while everyone is writing, nobody is reading, so the likelihood that whatever you type will actually be read is minimal. Sometimes you will find amusing anecdotes about Yahoo! boards, most notably the bored posting of company big wigs trying to pump up their stock. A phenomenal example of this is Whole Foods CEO John Mackey who for years posted under the pseudonym "rahodeb", an anagram of his wife's name Deborah (feel free to google his posts at your leisure). And while occasionally you may find a random gem by some disgruntled low-level employee, the probability of actually getting useful information as these types of medium is slim to none.

Next up on the value chain are semi-paid investment forums, newsletters and the thousands of financial blogs that have cropped up all over the blogosphere (we say this without any sense of self-referential sarcasm). Too many to list here, an occasional google search will reveal many, each with their own unique niche. Some good examples are value-investing-forum.com and http://www.valueforum.com/, but of which will not make you rich but have a solid following and you may find some angle on an investment that you were not aware of before.

So who is at the top? Many people will definitely point to http://www.valueinvestorsclub.com/, a rather secretive site that gets very few hits by the occasional web surfer, yet has made many people very, very rich.

Just what is VIC? The website is a portal, created in 1999 by Gotham Capital managers Joel Greenblatt and John Petry, which has a maximum membership quota of 250 people. The site is free, and anybody can register to see old recommendations (90 day lag), however to have access to real time ideas as they are presented you need to be invited. This happens by submitting an investment idea, which the Gotham guys go over, and if they like it, you get a thumbs up. Upon admission you simply need to provide between 2 and 6 ideas a year, which your peers need to value as better than average, to maintain your membership. Every idea presented within VIC gets a peer review and is rated on a scale of 0 to 10, to allow other investors to bypass the chaff. At latest count there were over 10,000 unique investment recommendations. And as the membership consists of 50% professional investors who actually have capital invested their recommendation, and 50% amateurs, the quality of the content is miles ahead of anything else on the internet. As new members are accepted, the worst pickers get ejected, sometimes to the tune of 20% of all members a year. In this way the site works exactly like Goldman Sachs with a very Darwinian model in which only the best and/or most prolific survive. Initially the forum's focus was on equities, although lately a significant amount of recommendations include bonds and loans.

As all members use pseudonyms and there is no way to message one-another, there is no risk that an entrepreneurial member can solicit others and form a mega hedgefund filled with the best analysts out there. Only Greenblatt and Petry know the identities of each member and what company they come from.

Greenblatt and Petry have a reasonable argument for the centralization of information: they "built and manage the community for free, and want to retain the intellectual capital in the community."

So if you think you have what it takes, go forth and submit your idea... If it is good enough you just may get access to the mecca of investing, where hedge funds go to push their books, and just the appearance of a long or short recommendation is rumored to have been able to move the stock up to 10%, or at least it did in the heyday of hedgefunding.

In a move geared to stop the daily drainage of its currency reserve, Russia is considering "dirty-floating" the ruble. While we are not sure what dirty floating is, but sure like the sound of it, we assume the impact on the ruble will be to send it plummeting. Russia had been keeping the ruble in a dollar-euro trading band, meaning it was funding the deficit to prevent the ruble from crashing. "A dirty float would look like it was a free market but the central bank would still have a measure of control" according to Nikolai Kashcheev, head of economic research at Moscow-based MDM. Despite the existing trading limitations, the ruble still lost 29% of its value against the dollar since August. On January 19, the Russian Central Bank sold $11 billion as the ruble weakened against the dollar for the 7th trading day this year.

Anyway, we love the concept of making something look like it is a free market. We have no doubt that the ruble will slowly commence its climb to attain the phenomenal exchange rate of the Zimbabwean dollar's $100 trillion/$1 US. At least this will allow the state to inflate all its problems and while a repeat of Russia 1997 is almost guaranteed, it will let the country have a fresh, post bankruptcy start in a sub-$50 oil world.

Well, can't say we didnt see it coming. Portugal was downgraded with impunity by S&P from AA- to A+ on the belief that "the government's structural reform measures relating to the economy and public finances have proven insufficient to bring about convergence with the 'AA' peer group." And what a high quality peer group it is.

Analyst Trevor Cullinan does not mince his words: "In our opinion, Portugal faces increasingly difficult challenges as it tries to boost competitiveness and lift persistently low growth. This, together with a heavy general government debt burden, leads us to believe that Portugal is unlikely to make the necessary structural improvements to remain in the 'AA' peer group."

While this is totally expected, sovereign CDS traders who were long Portugal CDS have taken half a day off today.

The entire airline space today was getting whacked in early trading. Delta was down over 10%, United was down roughly 9%, and American was down over 20% after the last two announced weak earnings with the major culprits given were a sharp drop in capacity and load factors on the revenue side, and bad fuel hedging on the cost side. American is being punished the most as it noted it still has 45% of its Q1 fuel hedged at $2.58/gallon or $108/barrel. United on the other hand stated that it's mark-to-market loss on fuel hedges gone wrong is $566 million, and that its hedging counterparties held $965 million in cash deposits.

Tomorrow we will see how the two biggest hedgers in the space, Southwest and JetBlue, performed in the fourth quarter, when they both announce results before market, and both have a conference call at 11:30 am. As we noted previously, we are concerned mostly about Southwest which we think may be punished for their prior significant hedging position.
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Bloomberg is reporting that last quarter investors withdrew $152 billion from hedge funds. While i have read about 10 different version of this number (anywhere from $100 to $300 billion) this is amazing considering that virtually every hedge funds has gated redemptions. One can only imagine how many times bigger this number would have been if hedge fund managers did the honorable thing and actually gave investors full access to their funds.
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Looks like Mary Schapiro is eager to do something on her first day in office. Instead of focusing on the $1 trillion asset bubble and the thousands of scammers and ponziers, she has decided to go thru Steve Jobs' dumpster and check for old syringes and pill bottles. Enough already - give the man some peace. If as an AAPL investor you did not notice Jobs' loss of over 50 pounds in a year and did not make your own decisions about his "key man" status at the company, then it is your fault if you bought at $180. Everyone knew that there could be something wrong with Steve: it is not Apple's fiduciary obligation to report on his health. Are there no more pressing issues for the SEC to be focusing on goddammit?

In other news: Tim Geithner has been carefully watching and learning from Tim Roth's brilliant insights NBC's new series Lie to Me.
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In his 2008 self evaluation letter, Richard Perry notes all the mistakes that the markets did last year in not agreeing with his assessment of what sound investments are. Notable among them is the short squeeze in Volkswagen shares, which the 1 Sutton Place resident attributes as the main cause to his -26.8% performance in 2008. As every single hedge fund and their grandmother was in this trade, it is good to see that contrarianism is not one of the reasons Perry notes for his downfall.

In terms of current investments, the fund has invested 29% of the Perry money in credit: 78% of this is in stressed credit at 50% of par, and the balance is in mortgage credit also at 50% of par... "There is ample room for price appreciation on the credit investments" is the justification given... Well seeing how every other hedge fund is in this trade again, there is ample room for depreciation as well, we would add. And, also, Mr. Perry "investing prematurely on an unhedged basis" is not why you pocket 2/20... Just saying
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At 9PM Eastern, the Chinese will announce their Q4 annualized GDP YoY change number. The consensus is 6.8% according to Bloomberg. This is a drop from 9% as of the prior reading. As Paul Kedrosky observes, the likelihood for a (much) lower number should not be excluded... 0% China GDP growth was presented as one of the major fat tail events of 2009 which in the current market environment means it is an almost virtual certainty.
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The man who had lent Bill Clinton his chopper, was found dead on Monday in an apparent suicide. Patrick Rocca, 41, died from a single gunshot to his head in his home in Holmeleigh, an exclusive residential enclave on the edge of Dublin's Castleknock Golf and Country Club. Apparently Rocca lost millions when Irish banks, specifically Anglo Irish, were nationalized and their equity value was destroyed. Patrick had $20 million in personal loans tied to Anglo Irish. He leaves behind a wife and three children...
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The expectation is that Nielsen Co. (Caa1/CCC+) will be coming to market momentarily to take advantage of "demand" for junk debt. Apparently the issue will be $300 million maturing in 5 years. We say the OID will be 25 points and we also take the under.
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Tuesday, January 20, 2009

Today's vomitfest in the markets apparently was greeted by holders of HF LP interests with a sense of utmost urgency/capitulation. In a nutshell - not a single bid, and over $150 million in ask interest just on Feb. 21. Among the more notable parties on the selling block:

Chris Cox has said enough and resigned today at noon. After single-handedly destroying the primary U.S. regulator Cox took the back door. His replacement is Kappa Beta Phi sister Mary Schapiro who ran FINRA - the second most ineffectual regulator in the U.S.

Well, Mary, after Cox's stellar performance, it should not be tough to improve on expectations that are really low, kinda like Obama and all.

These headlines just hit. Let me paraphrase: "We are f@*&#d. Send guns, ammo and lawyers." Oh, and GM needs to take down breakeven level for future. Hey Bob Lutz, good work reading our suggestions. Curious just how many times the new "conservative" plan will have to be reworked.